How To Use The Income Statement
Posted: Thursday, December 17, 2009
by Lucy Rudnicka
http://www.financialsforyou.com/financial-templates.php
When it comes to running a small business, your most valuable tool is the good old monthly income statement. This is how you will see whether you made a profit for the month, or not. And you will see all the components of that profit or loss at a glance. Digging deeper into any of the main categories will allow you to become aware of the reasons behind an especially good or especially poor performance in that area during the given month.
Sales or Revenues
This is what most business owners are very familiar with. How much did we sell this month? It seems to be a very important question. In fact, for many business people it is their number one priority. That's a mistake. It should never be your number one priority. It needs to be your number two priority. And that's why we are talking about an income statement and not a sales statement.
Your top priority should always be how much income you have made this month (this quarter or this year), but we are getting ahead of ourselves...
Cost of Goods Sold
This sector shows you how much the products or the services you sold cost you to make or to procure. Depending on whether you are a service provider or a manufacturing company, this sectionwill have a different make up. For example, a manufacturer will see here his cost of products manufactured including labor, materials and overhead. If you sell goods which you purchase, this section will show you how much you paid for what you have sold. Shown here are all direct expenditures involved with acquiring and making the product ready for sale. That includes freight-in expenses.
Gross Margin
This is one of the most important lines on your income statement. I would even venture to say it is more important than the Sales. This shows you how much money you have made before all your operating expenses are deducted. It is vital that you have good systems in place to calculate this information on the individual product basis. If you sell services, it is important for you to know this number for every service provider you employ. And if you pay sales commissions to a sales force, you should base them on this line and not on the sales. This would ensure that your sales force is encouraged to procure profitable sales and not just grow your top line without any regard for profit.
Operating Expenses
This category will list all the general expenses your business incurs that aren't directly involved in the production or acquisition of your products or services. Some examples of expenses are:
Advertising and Promotion
Selling and Administrative Expenses
General Office Expenses
Insurance
Depreciation
Operating Income
This is the result of your Gross Margin less your Operating Expenses. This line shows you how much money you have made as a result of activities directly involved in the operations of your business. The only other elements to consider below are interest income and expense and any other income and expense items which are not part of your main business operation. So, for all intents and purposes, we could call the Operating Income your "bottom line".
Other Income and Expenses
This section is reserved for income and expense items which are not related to the primary business activities of your company. For example, you could see here income generated from your subletting some of your space. Such financial results need to be shown separately from the operating activities, because they could mislead a reader of the income statement into thinking the company is doing better or worse than it actually is only because it engaged in some one-time activity not related to its core business.
Net Income
This is your "bottom line", the profit after all your expenses have been deducted. This end result will be most meaningful to you after you thoroughly understand all the other components of the income statement. This is what investors look at to see the profit for the year attributable to the shareholders.
Read more about the http://www.financialsforyou.com/small-business-articles-profitmargin.php income statement, financial ratios and the other key business financial statements.
Here is a professionally prepared http://www.financialsforyou.com/profit-and-loss-template.php"; income statement template.
Lucy Rudnicka is a former Corporate Controller. She now owns her own Accounting Services firm and works primarily with small businesses by providing them with outsourced bookkeeping and part-time Controller services. Visit her site to get your FREE Small Business tips .
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